The Nelson Cotton Company Ltd is looking to determine its cost of capital and has asked you to assist. The information available includes the following: Preference Shares: The preference shares were issued for $6 with a 10% dividend. The current market price is $9. When they were initially issued, they issued $36m worth of shares. Debt: The market value of Debt that matures in 15 years is $75m, trades at par and pays a 4% coupon per period (8% per year). The market value of Debt that matures in 30 years is $25m, trades at par and has an EAR of 7%. Ordinary Shares: The company also has 50 million ordinary shares on issue with a market price of $4 each. The Beta of these shares is 1.25, the market risk premium is 4% a and the risk-free rate is 5%. These shares last paid a dividend of 20 cents with an expected growth of 3%. Other Information: Cormans tax rate is 30% Calculate the following:

*a) Determine the EAR for the debt that matures in 15 years. 

 

b) Determine the return on debt that needs to be used in your WACC calculation. Calculate this on an after-tax basis. 

 

c) Determine the required return on the of preference equity

d) Determine the required return of the ordinary equity using the CAPM 

e) Determine the required return of the ordinary equity using the dividend discount model

f) In two sentence only, explain why the two methods used above to calculate the cost of equity may give us different answers for the same organization.

 Determine the weight of debt, ordinary equity and preference equity to be used in the calculation of the after tax WACC. 

 

h) Calculate the after tax Weighted Average Cost of Capital (WACC). Assume you use the CAPM cost of equity in your calculation.